How does debt affect a mortgage application? It’s a good question that lots of potential home buyers ask their computer or smartphone each year.
We’d all love to apply for a mortgage without any debt, but unfortunately, that’s not realistic for many working families. Life doesn’t always go to plan and we might have found ourselves in a spot of financial trouble along the way. So, will our existing debt stop us from getting a mortgage?
Read on to uncover the key details.
Can I Get a Mortgage If I Have Debt?
It is possible to get a mortgage if you have debt. If you have credit card debts, unpaid personal loans or any other type of common debt in the UK, it is certainly still possible to secure a mortgage. However, people might have too much debt to get a mortgage because they cannot prove they can repay their debts and repay their mortgage at the same time.
Medium income earners who manage to get a mortgage while also having debts tend to secure mortgages with a higher interest rate. This means you will typically pay more for your mortgage.
How Much Debt Can I Have and Still Get a Mortgage?
There is no magic figure on how much debt you can have and still get a mortgage because lots of factors will need to be considered. The amount you want to borrow, your income, your credit score and the tests used by lenders will decide if the amount of your debt is a problem or not. If you feel like you need to wait for your credit score to improve before applying for a mortgage, read How long does it take for your credit score to go up after paying off your debt.
So, How Do Lenders Assess Debtors for a Mortgage?
Mortgage lenders will first check your credit score to gain an overall picture of your financial health and any outstanding debts. They will then apply other tests, such as:
1. The Debt-to-Income Ratio
A debt-to-income ratio is the ratio of your monthly income against your debts and monthly expenses. It is expressed as a percentage. You can work out your debt-to-income ratio by:
- a) Adding up recurring bills and debts (e.g., proposed mortgage repayment, loan repayments, car finance etc.)
- b) Adding up your monthly income, including wages, state benefits and other regular income before tax and NI contributions
- c) Divide your monthly debt by your income, then multiply it by 100
For example, if your monthly debt and expenses are £1,000, and your monthly income is £2,500, your debt-to-income ratio would be 40% (1,000 / 2,500 * 100). If you apply for a mortgage as a couple, you will need to factor in all debts and monthly expenses you (will) have and both incomes.
Nationwide Building Society states that anyone applying for a mortgage should have a total debt-to-income ratio below 45%. This is industry standard advice. Obviously, the lower the percentage the better.
If your personal debts do not force your debt-to-income ratio above 45%, there is a good chance you can still get a mortgage. However, if your personal debts make the debt-to-income go above 45%, there is a chance you might not be able to get a mortgage until you reduce your debt/monthly repayments.
2. The Credit Utilisation Rate
Another statistic a mortgage lender will scrutinise before agreeing to give you a mortgage is your credit utilisation rate, also referred to as a credit utilisation ratio.
This is a percentage stating how much you owe divided by your current credit limit. The data scrutinises revolving credit only, which are lines of credit you have with no end date. The most common example is a credit card. The figure will not take into account debt that has an end date, such as car repayments.
If you have three credit cards with a balance of £2,000 each, you will have a revolving credit limit of £6,000. If you have a £100 balance on two of those cards and a £1,000 balance on the third, you will have used £1,200 of your £6,000 limit. To work out your credit utilisation ratio, you simply take your used credit (£1,200) and divide it by your limit (£6,000), which in this example comes to a credit utilisation rate of 20%.
The general consensus is to aim for a credit utilisation rate below 30% to show you are managing your finances well and not relying too heavily on credit.
Should I Use Savings to Clear Debt or Make a Bigger Deposit?
There are pros and cons of using your finances to clear debt before applying for the mortgage or using your finds to make a bigger deposit.
Using Savings to Clear Debts
- Reduce your debt-to-income ratio
- Reduce your credit utilisation ratio
- Improve your credit score
- Improve your chances of getting a mortgage
- You would have a lower deposit
- You might have to pay higher interest rates
Using Savings to Make a Bigger Deposit
- Reduce the size of your mortgage
- Could reduce interest rates and get a better deal
- Increase lender options available to you
- Might be able to buy a bigger or better property
- Your uncleared debt could deny you a mortgage
Generally, you should use your savings to clear debts and reduce revolving credit if you have high debt-to-income and credit utilisation ratios that could prevent you from getting a mortgage altogether. Otherwise, you may want to seek professional advice for the best course of action.
Will Student Loan Debt Affect a Mortgage Application?
Student loans will not appear on your credit score and will not usually raise a red flag with a potential lender.
These debts will be included in your monthly debts as part of your debt-to-income calculation, so they can potentially affect a mortgage application. However, as these are debts only paid back when you are earning over a certain threshold, lenders will not usually reject a mortgage because of student debt on its own. If you had lots of other debts that give you a high debt-to-income ratio, then your student debt could contribute to a rejection.
I Have Debt and Want a Mortgage, What Now?
As you will have realised from the above, getting a mortgage with debts is possible, but the success of a mortgage application hinges on personal finances and specific circumstances. Start by trying to hit the benchmarks:
- a) Aim for a debt-to-income ratio below 45%
- b) Reduce your credit utilisation rate below 30%
- c) Check and clean up your credit score when appropriate
To help put yourself in the best position before applying for a mortgage, you may want to use professional advice. Moreover, you might want to seek out authorised lenders who have a reputation for providing mortgages to people with debt.
A big thank you to Scott Nelson for this fantastic guest post.
Scott is a financial services expert, with over 10 years’ experience in the industry. Troubled by the lack of moral conscience in the industry, Scott decided to use his insider knowledge to give genuine advice to those struggling financially. He’s recently moved out of London to the rural area of Malvern to pursue this ambition.